Medical Matters – Silent Side Effects…

At the time of writing this article, the 2012 Budget is still hot off
the press. It would thus seem logical that this article should commence with an
analysis of the 2012 Budget.However, it is more beneficial to readers to
discuss the 2011 Budget changes so that the 2012 proposals can be put into
perspective.

2011 Budget changes

Two changes were promulgated, both of which became effective 1 March
2012.

1. Conversion of medical scheme contributions into tax credits.

2. Broadening the definition of ‘dependant’ for the purposes of section
18 of the Income Tax Act No. 58 of 1962, as amended.The change broadens the
meaning for taxpayers to include immediate family members for whom they are
liable for family care and support.For example, where siblings incur medical expenses for their sister who has a disability as defined in section
18(3) of The Act.

The amendment is rather tame, as it does not go far enough by including
such a dependant in section 18(2)(b) (as the writer had suggested to The
Minister of Finance) in order to allow the taxpayer to deduct all his or her
medical expenses under section 18 of The Act.In other words the 7.5% capping
still applies.For the sake of brevity, therefore, no further discussion on this
is deemed necessary herein.

Conversion to tax credits

The conversion of medical scheme contributions into a rebate is known as
the medical scheme fees tax credit (the tax credit).The law governing the
application of the tax credit is set out in a section (section 6A of the Act)
specifically inserted for this purpose.

The tax credit is non-refundable and is treated in the same way as the
other rebates: namely, the primary rebate, the over 65 and the over 75
rebates.In other words, the insertion of the tax credit means that the act now
has a quartet of rebates.A quintet of rebates/tax credits could be in force if
the 2012 Budget proposals are promulgated, which is proposed to take effect
from 1 March 2014.Is this the start of a large collection of rebates in our
law? Will such conversion prove to be successful?

The amount of the tax credit for the 2013 tax year is:

i) R216 in respect of the benefits to the taxpayer.

ii) R432, in respect of benefits to the taxpayer and one dependant.

iii)R432, in respect of benefits to one taxpayer and one dependant, plus
R144 in respect of benefits to each additional dependant, per month.

The rationale for the conversion of medical scheme contributions is that
the tax credit applies equally to all taxpayers.The conversion to the tax
credit is based on 30% of the amount of the tax deduction which would have been
deductible in the absence of the conversion.It can be seen therefore that the
conversion affects taxpayers paying tax at a marginal rate of 40% by 10%.By contrast,
taxpayers with a marginal rate of 18% gain 12% as a consequence of the
conversion to the tax credit at 30%.

An anomaly exists as the exception to the application of section 6A
(i.e. the conversion to the tax credit) does not apply point for taxpayers over
the age of 65.For taxpayers over the age of 65, therefore, the status quo
remains that all medical scheme contributions are fully tax deductible.This
contrasts to taxpayers who have a disability within the family.

This anomaly arises because the vulnerable group of disability taxpayers
are not protected in the same way as those taxpayers over the age of 65.Prior
to the conversion to the tax credit, the disability group was allowed to deduct
its full medical aid contributions in the same way as taxpayers over the age of
65.Is it discrimination against the disability group? It is anomalies like
these that creative tax planners thrive on.No doubt tax law advisers who
specialise in the provision of tax law advice to the disability group will be
kept busy in order to ensure that the playing field is equal between taxpayers
over the age of 65 and the disability group.

To make matters even more complex, the law provides for the disability
group to deduct the amount of medical aid contributions which exceeds four
times the amount of the (section 6A) tax credit.Such deduction is made under
section 18 of the Act and is thus not a rebate or tax credit.

There are three sets of taxpayers – those over the age of 65, the
disability group and all other taxpayers.The treatment of the three groups is
as follows:Over 65 taxpayers do not obtain the tax credit but are allowed
a deduction for all their medical aid contributions under section 18.In other
words, there is no change for taxpayers over the age of 65.

The disability group receives the tax credit under section 6A as
discussed above (thus 40% marginal tax rate taxpayers lose 10% under section
6A) and obtains a tax deduction under section 18 of the amount of medical aid
contributions which exceeds four times the tax credit.This change will
adversely affect many vulnerable taxpayers.

All other taxpayers – the amendment to the tax credit is as per section
6a.The excess of four times the tax credit of medical aid contributions (as for
the disability group above) is relevant, however, such excess forms part of the
overall deduction allowable under section 18 (i.e. "out-of-pocket-expenses”
~discussed below) i.e. the reasonably well known 7.5% "capping” rule
applies.For the sake of brevity, therefore, the "capping” rule is not
discussed herein.

2012 Budget proposals

Conversion of medical expense deductions

Most of the hype after the 2012 Budget proposals related to converting
additional medical expense, or often known as out-of-pocket expenses (OPE)
deductions to tax credits with effect from 1 March 2014.The rationale for the
conversion is the same as that for the conversion of medical
scheme contributions to the tax credit – to ensure improved equity.

For over 65s and the disability group of taxpayers, it is proposed that
OPEs be converted to a tax credit at the rate of 33.3% and in addition
medical scheme contributions in excess of three times the total allowable tax
credits. (Page 52 of the Budget Review is the source of the above which
explicitly includes the over 65 group of taxpayers.)

Are the complexities already showing signs that many adverse side
effects will occur? The over 65 group of taxpayers does not receive the
tax credit (under section 6A) so the reference to three times the tax
credit is an unnecessary side effect? For all other taxpayers, the conversion
is proposed to be at the rate of 25%

Apart from the negative impact the conversion will have on many
taxpayers in the disability group whose marginal rate of tax is 40% (a 6.67%
loss), there are many other concerns about the conversion of OPEs in their
entirety.OPEs are also referred to as catastrophic expenses. (The National
Treasury has used the word catastrophic in the past, for example Page 18 of The
Tax Policy Discussion Document for Public Comment – on The Conversion of
Medical Deductions to Medical Tax Credits – Issued 17 June 2011.)

The use of the word catastrophic is most pertinent when considering
medical matters and assessing the efficacy of future tax laws, or otherwise.The
side effects, or perhaps even considerable core effects,of the conversion to
tax credits will prove to be severe, if not financially crippling.To reiterate,
the stated intention of the conversion to tax credits is to ensure increased
equity of the tax system.It does not appear that sufficient attention has been
made to the inevitable considerable increased inequity.

As referred to above, tax credits are not refundable and cannot be
carried forward. In contrast, medical expense tax deductions under section 18 (as
is currently the case) can and does create substantial tax refunds.The writer’s
main concern with converting catastrophic expenses to non-refundable
tax credits, or not being able to carry them forward to the following year
of assessment, is that by their very nature they are unpredictable and can be
substantial (for example, road accidents).

Take for example a taxpayer who has been fully tax complicit and has
paid tax at a marginal rate of 40% for 25 years.Catastrophically, the taxpayer
is unable to work for two years as he recovers from a serious road accident.It
stands to reason that during such time the taxpayer would incur substantial
OPEs.Assuming his OPEs during the two-year period are R1.5 million, the
taxpayer will obtain no relief for his OPEs, or taxable loss of R1.5 million if
the proposed conversion is promulgated.Seem fair and equitable?

In the absence of the conversion, the taxpayer would be able to carry
forward the OPEs or his taxable loss by virtue of section 20 of the Act, which would
shelter R1.5 million of his future income.This appears to be much fairer, in
the writer’s opinion, than the taxpayer losing R1.5 million because he has had
a catastrophic accident and tax deductions are converted to tax credits.

The conversion can and will create serious and substantial inequity in
monetary terms to affected taxpayers.I would go even further and suggest
that the Minister of Finance considers the position where losses maybe
carried back(1 – 3year) to the taxpayers prior year of assessment.Carry back
of losses is by no means unknown in tax jurisdictions around the world.The
refund obtained from the carry back of the loss will allow the taxpayer to
finance some of his OPEs.This seems fair to the taxpayer after all the tax he
has paid over 25 years.

Would the conversion not be inequitable?

How does the previously high earning taxpayer fund OPEs? The proposed
conversion is likely to come under further close scrutiny before it is
promulgated, if indeed it is. While the writer has focussed on a taxpayer
paying tax at a marginal rate of 40%, the same could be said of 18% marginal
tax rate taxpayers.Potentially could be even more financially "crippling” for
such taxpayers as they may have no assets (such as ownership of a residential
property) which they could sell to assist them to finance the exorbitant
costs.

Special trusts

The Draft Taxation Laws Amendment Bill, issued on 13 March 2012,
provides for amendments to be made to the definition, in section 1 of the Act,
of ‘special trusts’ as contained in paragraphs (a) and (b) (section 1 of the
Bill).

The only proposed amendment to a paragraph (b) special trust is the
change of the age from 21 to 18. Accordingly, there is little change.The
major proposed change is to inter vivos special trusts as contained in
paragraph (a) of the definition.I have written and spoken at length about
paragraph (a) special trusts and it came as no surprise that the definition has
been amended by the deletion of subparagraphs (a)(i) and (a)(ii).The
subparagraphs have been replaced by the insertion of the definition of a
‘disability’ in section 18(3).This is due to the fact that there was no
alignment between the two subsections.

Since the two subsections refer to similar issues (i.e. disabilities),
it would bring more symmetry to the legislation if the definition of section
18(3) replaced the existing subparagraphs.I alluded to this discrepancy in an
article in 2010 (www.bendelsconsulting.co.za – Press Box: Tax and disabilities
–how special are your trusts?).The suggested amendment was one of the budget
tips that Bendels Consulting sent to the Minister of Finance.

As mentioned in a recent article in the TaxTalk newsletter (Special
Trusts – Naturally Speaking? –http://

www.taxtalkblog.com/?p=5943 we highlighted the fact that our top 2012
Budget Tip went unheard. So we can take little credit that the amendment to the
definition of paragraph (a) special trusts is included in the Bill.(There may
have been several tax law experts specialising in paragraph (a) special trusts
who advised the Minister on this.)

It brings a whole new complex dimension to the drafting of
paragraph (a) special trust deeds.Naturally, a deep knowledge of section
18(3) and its associated intricacies will be required.This is new ground
for those Tax Law and other experts in this field who do not specialise in tax
law and disabilities as contained in section 18(3).

What did come as a surprise, however, is the fact that paragraph (a)
special trusts may be created for more than one person.Previously a special
trust could be created only for a person (the singular providing the authority
for that).If promulgated, broadly the trust can be created for more than one
person provided that all persons are relatives.

The proposal’s intention is sound as it is not unknown, for example, for
a family to have autistic triplets.To create a separate trust for each child
adds unnecessary additional costs and administrative burdens.About six months
ago, I was asked whether a special trust could be created for three children.
At that time, I said no.As time has passed, my opinion would be a rather
different one as the changes to the definition of paragraph (a) special
trusts came into operation as from 1 March 2012 (subject to promulgation).

WHY REGISTER WITH SAIT?

Section 240A of the Tax Administration Act, 2011 (as amended) requires that all tax practitioners register with a recognized controlling body before 1 July 2013. It is a criminal offense to not register with both a recognized controlling body and SARS.